Why entrepreneurs and VCs perceive risk differently

Last week I wrote that a $1m revenue run rate and 20% month-on-month growth is a good benchmark to assess whether a transactional company is ready for a Series A, and then over the weekend I had a conversation on Twitter about whether investing in companies with a $1m revenue run rate was ‘venture’ capital or ‘growth’ capital. There’s definitely a feeling out there that businesses with a $1m revenue run rate are well-established and thus have a growth risk profile rather than a venture risk profile.

That got me thinking about why people perceive risk in startup companies so differently, and reflecting on my experiences working with true startups here at Forward Partners was particularly illuminating. I’m excited, for example, about our investment in SnapTrip, which we backed at inception with a team of one last December. They’ve developed a great understanding of their customers and have made rapid progress with the product, commercially speaking and in building out their team. Compared to where they were at the beginning of the year the proposition is significantly de-risked. I have to constantly remind myself that they are barely six months old, and that there is still an awful lot more to prove than has been proven.

That, in a nutshell, is why entrepreneurs and VCs see risk differently. When an entrepreneur gets her company to Series A the company is an awful lot less risky than it used to be, and hence is comparatively safe – to the entrepreneur that just feels like ‘safe’. The VC, however, knows that however much her company looks great and has addressed the risks in it’s business model, history has shown that companies with similar profiles still only have a relatively small chance of success.

Many people think that VCs in Europe are failing our entrepreneurs by not taking enough risk. I’m not so sure that’s right. I think they just have a different context (generally speaking that is – there are good and bad VCs out there, just like every other profession). One thing I can say is that when I’ve seen VCs try to increase their risk profile better returns haven’t usually followed.

 

  • http://azeemazhar.com/ azeemazhar

    Nik

    I guess the question is at what point of de-risking are you looking to get involved.

    At the point of $1m in sales for a SAAS business, translates to roughly $80k MRR, you probably don’t have your marketing economics fully worked out; nor will you have an understanding of your churn rates. You should be able to achieve $1m annualised sales (i.e. $80k in MRR) within 12 months, if not before, depending on how ready your market is.

    I’ve heard that $1m in sales ($80-100k in MRR) for a SAAS business, with its customary 90%+ gross margin, should score more like a $5-8m round. But that is still venture capital, not growth capital

    Hard to think that for any business with a reasonable TAM revenues of below $10m a year could qualify for anything but ‘venture capital’. Above $10m a year (which for a SAAS business would imply a valuation of $150 – $200m) we’re talking growth.

    What do you think?
    a

  • http://www.theequitykicker.com brisbourne

    Hi Azeem – that’s about right. I always think that for a software company $10m (or maybe £10m) in revenues is a major milestone. It’s very hard to get to that level without having a great product and figuring out route to market.
    tks
    N